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Wednesday, May 26, 2010

Investing in Development – Looking back at Year 1

PONDERING OUR EXISTENCE

Invested Development is very close to celebrating our one-year anniversary (and I have the $500 incorporation renewal to prove it). For some reason, anniversaries often become times of reflection, introspection and (the always dangerous) existential pontification. Considering that this is our very first anniversary, we have very little time for looking back or inwards, but we have spent a lot of time pondering our own existence.

So I’ll stick to the latter. Invested Development exists in a broad sector of financial capital intermediation. This means we help people with money put that money where people who need money can get it. In our case, we do this by helping high-net-worth individuals and foundations make seed-capital investments in start-up businesses with products or services for the poor in emerging markets

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There is a lot in that last sentence, so let’s break it down. High-net-worth individual is vague at best. Legal definitions offer only a little more clarity. Regulators use the term “accredited investors”, usually defined as someone with net-worth over one million dollars (excluding their first home)[1]. We have a higher bar: Can the individual afford to lose the money they are investing and not jeopardize their (and their family’s) quality of life. It’s a touchy feely qualification, but despite the money, spread-sheets and legal contracts, this is a touchy-feely industry.

Seed-capital investments (or Angel investments…but we will open that can of worms at a different time) are equally subjective. We will stick with defining seed-capital investments as the money that comes from outside of the founders but often precedes the company having significant revenue. That last part is tricky. Significant revenue can mean a lot of things and we can’t really put a finer point on it. That part is subjective and industry dependent (honestly, in many cases it means zero revenue).

Products and services for the poor…this is where the real controversy begins. In a previous life I worked as an economic development consultant and I could define “poor” with aplomb. These days I let others focus on the definition and I stick with “I know it when I see it” (a phrase most often associated with pornography thanks to the Honorable Justice Potter Stewart[2]). If prodded, of course, I can still dig-up a few facts. For example, there are over three billion people (nearly half the population) in the world who live on less than $2.50 per day [3]. Less than $2.50 a day sounds poor, but not necessarily. If we take the UN definition of poverty it’s not so clear:

"a condition characterized by severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education and information. It depends not only on income but also on access to services.[4]"

That type of confusion is why we don’t bother trying to define poverty. However, the definition itself provides an excellent segue back to our original topic…why we (as a company) exist.

DEFINING POVERTY

Poverty is poorly measured by income alone. One of the most illuminating books I have ever read “Off the Books: The Underground Economy of the Urban Poor” by Sudhir Alladi Venkatesh, illustrates the barter economy leveraged by the poor in the absence of cash currency. His numerous examples are based in a Chicago neighborhood, but it is easy to see how they can be translated into Brazilian Favelas, Mexican Colonias, or Indian Slums. The barter (often called “informal”) economy multiplies the services that many poor people can obtain with their limited income. Of course, the poor struggle to barter with anyone other than themselves. That means they only have access to the products and services available within their community. That can be severely limiting.

This limitation helps us begin to qualify our “I know it when I see it” statement. If the poor can access existing products and services (more services than products for the obvious reason that tangible goods are scarcer in poor communities than time) we need to focus on what doesn’t currently exist. Medical care, financial services, energy, communications and education are key services that often lag in poor communities. Considering their importance, we can (and often do) use them as a proxy for deciding who is poor. The World Development Indicator[5] focus largely on these areas and are widely cited by government and non-government organizations seeking funding to assist the poor. A more salient example are the United Nations Millennium Development Goals[6] which not only illustrate our constant struggle with defining poverty, but provide another perfect segue back to our topic as the most well publicized example of the problems we have with combating poverty.

LOOKING AT A GIFT HORSE IN THE MOUTH

Our existence (again, as a company) is predicated on the theory that the current system of increasing the supply of products andservices for the poor isn’t working. The current model is highly polarized, with donation supporting foreign Aid on one side and unbridled capitalism on the other (maybe a simplification, but not really as much as we’d like to believe). Foreign Aid is provided in many forms, but it is nearly always subsidized by well-intended donors (countries are the largest donors). There is plenty of controversy about the best way for rich countries and their citizens to help poor countries and theirs. I won’t pretend to be qualified to weigh in on the broad topic. However, there are few truths that can’t be ignored.

“Never look a gift horse in the mouth” is a fitting expression that encompasses some of the biggest failures with traditional foreign aid. The proverb stems from a custom of checking the age of a horse that you are going to purchase by looking at its teeth[7]. Of course, when that horse is a gift it is considered impolite (and impudent in a competitive giving environment) to see if the donor is lying about its age. It’s not a stretch to say that recipients of Aid are equally reticent, even if what is being given to them may end up being more of a burden than a relief (good intentions aside, an old horse can do little work and still needs to be fed). From a political standpoint, traditional Aid conjures another gift horse analogy; theTrojan kind, but that discussion is better left for another time.

On the other side of the spectrum is unbridled capitalism. History is disgracefully scarred from the wounds of unchecked profiteers raiding, looting, enslaving and murdering in the name of capitalism. And fresh wounds of war profiteering, financial market rigging and environmental destruction prove that, despite our amazing progress on so many fronts, we cannot be trusted with completely free-markets. That said, nothing (and I’m pretty sure I’m right about this) that we know of is more efficient and democratic at providing products and services to the masses than capitalism.

This deserves some explanation. Efficiency is often a proxy for profits and competitive advantage. But it also drives downprice, expands reach and improves quality. Since we have established that poverty is more about the inability to access sufficient products and services, efficiency is a great thing for the poor. Democracy, on the other hand, is rarely considered a pillar of capitalism (prerequisite yes, but not a pillar). However, when compared to the Aid gift-horse, it is very democratic. Although you shouldn’t be able to buy a vote, you most definitely vote with your money. Each purchase consumers make lets producers know what products and services consumers feel strongest about. However there are limits to this democracy. These limitations provide our final segue back to the original topic… our raison d'être.

In principle capitalism should be able to efficiently and democratically allocate our scarce resources in a more equitable manner (though not perfectly equitably, of course). But our current system of capitalism is rife with limitations (many of which stem from our own limitations). Beyond greed there is political expediency, geographic dispersion, technological limitations, cultural confusions and the monetary tower of Babel. But let’s only focus on what we, as an industry, can fix.

GURSKI’S LOAN SHARKS

Greed reminds me a lot of a study that a friend of mine, Brian Gurski, once undertook to better understand loan sharks (informal lenders) in New York City. Brian and I worked at ACCION New York (a U.S. based microfinance bank), and loan sharks were not only competition, but also the cause of a lot of pain for our clients. What Brian found not only amazed us all but changed the way we approached one of our biggest rivals. Contrary to our deepest held beliefs (and pop culture portraits) loan sharks are not vicious thugs in velour jumpsuits waiving bats and making unambiguous threats to borrowers and their families. Instead, Mr. Gurski found, they are old retired ladies trying to extend their nest-egg (not what you expected, right!).

So why do Gurski’s loan sharks remind me of greed? Because we so often think that the people behind global greed (tycoons, bankers, brokers and, increasingly, venture capitalists) are sociopathic misanthropes. They aren’t. The problem is the system, not the people. They, like us, are pawns in a game that they rarely understand the rules to. More importantly, they are so far removed from the originator and the end-user that they can’t possibly be companionate for either.

So there we have the conclusion of a year-long existential crisis. We, as seed capital facilitators focused on products and services for the poor, exist to help find a healthy middle ground between Aid and capitalism; to reduce the ills of greed by bringing financiers closer to end-users, and improve capitalism by ensuring that all costs of production are included in the price of consumption (wait, I didn’t actually cover that last one did I? Guess you will have to check back for my next post).

[1] The SEC defines an Accredited Investor as “a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase…” (http://www.sec.gov/answers/accred.htm) Accessed on 05/18/2010.